U.S. equity performance was mixed this month, with the Dow Jones Industrial Average, S&P 500, and Russell 3000 returning -0.41%, +0.16%, and +0.19% respectively.
Though equity performance could be considered being flat for the month, spikes in daily volatility were not absent as the CBOE volatility index, also known as the VIX, reaching 18.14 on 09/14/2016. This level constitutes the highest since the “Brexit” referendum in late June.
Performance dispersion in global markets remained elevated in September. Figure 1 shows the rolling 13-week and 26-week performance percentile rankings of each asset over the last 5-year period.
Assets in the top-right quadrant, for example, have performed well in the last 13- and 26-week periods, constituting a positive trend in the asset’s price.
Within our categorization, the top performers are MSCI Emerging Markets, High-yield fixed income, and MSCI All Country World ex. U.S. Short term performance of sovereign fixed income markets has been weak, and shorter maturity Treasury markets such as the UST 2yr and UST 5yr are in negative trends.
Finally, the foreign exchange market, particularly the British pound and Japanese Yen, continue to exhibit opposing trends relative to the dollar and have further contributed to FX return dispersion.
FOREIGN EXCHANGE FOCUS
Currencies, relative to the dollar, have followed divergent paths over the last year. Particularly, the British Pound remains weak, the Japanese Yen remains strong, and the Euro remains within a tight trading range.
Figure 2 shows the change in FX rate between USD and GBP, USD and EUR, and USD and Yen respectively. The rates are indexed to 100 in order to show how these currencies have fluctuated over the last 12 months.
Uncertainty around the British exit from the European Union continues to weaken the British Pound. The Bank of
Japan, by not increasing the amount of monetary intervention, helped the Japanese Yen to continue strengthening relative to the dollar.
In addition, during September, both the FED and the European Central Bank (ECB) met market expectations by maintaining benchmark lending rates.
With no significant change in expectations, the exchange rate between dollars and euros has remained within a tight trading range. The ECB holds another meeting on 10/20/16 and the FED releases its September minutes on 10/12/16.
Unfortunately the market will wait until early November for additional monetary policy data when the Bank of Japan and the FED holding meetings on 11/01/16 and 11/02/16, respectively.
OIL FOCUS
On September 28th, 2016, news of a potential OPEC oil production freeze shifted market expectations of the commodity’s price.
The proposed production cut ranges from 200,000 to 700,000 barrels per day and requires agreement during OPEC’s 11/30/16 meeting.
Assuming the midpoint of 450,000 barrels per day, the cut represents a decrease of approximately 0.47% of world oil production. If the agreement occurs and demand remains flat, it will mark the first time since December 2013 where supply is less than demand.1
On the day of the news, oil and oil-sensitive markets rallied as WTI crude oil futures increased 5.3%, the S&P 500 energy sector increased 4.3%, and the U.S. High Yield credit market increased 0.67%.
Despite the recent optimism, a performance analysis of different time frames shows a different story. Figure 3 indexes the price of crude oil to 100 as of 12/31/2013 and, subsequently, as of 12/30/2015.
From a shorter-term perspective, oil has increased approximately 30%, while from a longer-term perspective, oil prices would need an increase greater than 100% to reach it former peak.
EARNINGS REVIEW
Outside of monetary policy decisions, the next big market event relates to the Q3 2016 corporate earnings announcements season.
So far, market expectations estimate another quarter of year-over-year earnings declines. Should this be the case, it will be the first time we experience six consecutive quarters with year-over-year earnings declines since the 2008 recession.
Additionally, 16% of S&P 500 companies have already issued negative earnings per share (EPS) guidance, compared to only 7% that have issued positive EPS guidance.
The largest detractor of earnings growth in the S&P 500 continues to be the energy sector, which is still experiencing the effects of relatively low oil prices. Nine of the now eleven sectors are expected to report year-over-year sales growth.
The estimated sales growth rate for Q3 2016 is 2.6%, which is 0.1% higher than the same estimate from the beginning of the quarter. As of the end of September, the forward 12-month P/E ratio of the S&P 500 is 16.6, down from 16.9 one month ago. With earnings season fast approaching, it will be interesting to see which
sectors ‘hit’ and which sectors ‘miss’ earnings.2
LOOKING FORWARD
The calendar of future macroeconomic data will follow the traditional pattern. The Bureau of Labor Statistics releases September’s Employment Situation report on October 7th, Alcoa Inc. kicks off the earnings season on October 11th, and the FOMC publishes its minutes from the September policy meeting on October 12th.
Retailers in the U.S. are gearing up for the seasonal boost in spending from holiday shopping sprees; a phenomenon that has on average benefited the retail sector in the month of October since 2009, as measured by the S&P Retail Select Industry Index.2
The combination of earnings announcements, the upcoming unemployment statistics, and other macroeconomic data will provide insights for the Fed, which meets only twice more in the balance of 2016.
SUMMARY
During September, the market absorbed unexpected news within oil markets, digested expected results from central banks, and saw further dispersion in world currencies relative to the dollar.
The unexpected news of an OPEC supply freeze on 09/28/2016 reversed the negative intra-month performance and helped WTI crude oil and the S&P 500 energy sector to post +0.80% and +1.34% returns in September, respectively.
Across monetary policy, the FED and ECB matched market expectations with no change in target rates or monetary intervention. The Bank of Japan, however, did not meet market expectations of new stimulus; they announced targeting the yield curve with remaining purchases.
Relative to the dollar, the British pound continues to decline as “Brexit” fears remain, while the Japanese Yen continues to strengthen as the Bank of Japan offered no incremental increase in monetary stimulus.
In October, United States corporate earnings will be an important economic new data point, which will surely capture the attention of investors.
This article was written by Innealta Capital, a participant in the ETF Strategist Channel.